Before we get started, this is not a recommendation or endorsement to buy any token or vault mentioned.
During the crypto bull run, early DeFi builders introduced us to decentralized options through protocols such as Hegic and Opyn. While these protocols are still working to grow deeper liquidity and building new ways to productize DeFi options, one product stood out from the rest–options vaults. Ribbon Finance pioneered using decentralized options to offer exposure to different kinds of options trading strategies managed by their own smart contracts. Unfortunately, while Ribbon grew a user community interested in options strategies, some may have failed to understand that these strategies can also result in a loss of their deposited principal.
This stems from a common issue over using yield APY or APR to compare different DeFi products. This is a very flawed way to compare some DeFi offerings, especially options vaults. The underlying options that power these strategies have weekly expiration dates, meaning a shorter timeframe for potentially realizing a profit. However, when options vaults in DeFi such as Ribbon display Total Projected Yield (APY), based on annualizing the 4-week average weekly yield generated, despite the strategy exposing vault owners to buying and selling puts/calls with weekly expirations, I think we clearly set ourselves up for a mismatch of expectations. Annualizing the performance of these options vaults doesn’t make sense when projected yield can drastically change week-to-week based on the market structure, options pricing, and countless other factors.
I am not questioning the intentions of Ribbon or any other team that advertises the performance of options using APY/APR. In fact, Ribbon provides every bit of information on their UI about the very real risk that a vault can incur a weekly loss when options sold expire in-the-money. My ranting about the use of annualized yields for options vaults has more to do with a need to create neutral options strategies, which won’t risk depositors’ principal.
Since I’ve mostly avoided using options vaults, I was delighted to recently discover a new neutral-options vault strategy by Pods Finance, a protocol for decentralized options and derivatives strategies. The stETH Volatility Vault requires users to deposit stETH (staked ETH by the Lido protocol).
Here’s how it works:
- The vault uses 50% of the weekly stETH staking yield to create a long strangle, using ETH options.
- A long strangle is when an investor holds a position in both a call and a put option with different strike prices but the same expiration date and underlying asset. This strategy is profitable if ETH moves up or down 10%, so you’re betting on a big price movement but direction doesn’t matter, even if markets crash! (see explainer on Long Strangle below)
- This strategy is ideal for those already exposed to the price of ETH, but who want to earn passive income from ETH staking yields thanks to stETH.
- Because stETH is earning ~4% APR in ETH staking yield and the vault reinvests only 50% of the weekly accrued yield into building a long strangle position, depositors don’t risk losing their principal.
- Even if the options expire out-of-the-money because ETH price doesn’t make a big move, stETHvv holders are netting a ~2% APR, or 50% of the stETH yield.
- There’s a 0.1%…
DeFi Dad is one of the earliest power users of DeFi, having worked with early Ethereum startups going back to 2018, including Zapper.
